Corporate Investment and the Option to Repurchase Debt

Abstract

The presence of publicly traded debt in firm’s capital structure leads to coordination and restructuring problems as the firm nears financial distress and investment is distorted. Based on this perspective, I describe the market for debt repurchases as a substitute for renegotiation and examine whether deleveraging through repurchases improves investment efficiency. Using a sample of debt repurchases initiated by U.S. firms from 1996 to 2011, I find that firms are more likely to repurchase outstanding debt either by open market transactions or tender offers when investment frictions are relatively high. This improvement is more pronounced for firms with higher expected transfers to bondholders. To address the endogeneity of the repurchase choice, I examine an exogenous shock to the incentives to repurchase debt provided by a provision of the American Recovery and Reinvestment Act of 2009 and find similar improvements in investment efficiency.

Keywords: Corporate Investment, Debt Repurchases, Capital Structure

JEL Classification: G31, G35